Bank of England Cuts Growth Forecasts, Jobless Climbs

By Jennifer Ryan and Brian Swint

Aug. 13 (Bloomberg) -- The Bank of England cut its forecast for U.K. economic growth and held out the prospect of lower interest rates as unemployment rose the most in almost 16 years.

Governor Mervyn King said the inflation rate will fall below the 2 percent target in two years if policy makers keep the benchmark interest rate at 5 percent. Claims for jobless benefits climbed 20,100 in July to 864,700, the biggest increase since December 1992, a government report showed.

``It may still be summer but there is a feeling of chill in the economic air,'' King said at a press conference in London today. ``The British economy is going through a difficult and painful adjustment'' that ``cannot be avoided,'' he said.

The pound and government bond yields fell after the reports, which suggested the central bank may have room to lower interest rates as the economy heads toward a recession. Higher unemployment may prompt consumers to curtail spending and exacerbate the worst housing market slump since the early 1990s.

The pound fell to a 21-month low against the dollar. The British currency dropped to $1.8784 at 1:59 p.m. in London from $1.8968 yesterday. Two-year gilts jumped, cutting their yield 18 basis points to 4.471 percent.

Economists at BNP Paribas SA and JPMorgan Chase & Co. changed their forecasts and said the Bank of England may reduce its benchmark rate in November, not in the first quarter of 2009 as they previously predicted.

Sixth Increase

The economy will grow about 0.1 percent on a year-on-year basis in the first quarter of 2009, compared with a previous forecast of 1 percent, the Bank of England projections show.

``Broadly flat output means there is a possibility of a quarter or two of negative growth,'' King said, when asked about the risk of the first recession since 1991. ``There are clearly downside risks.''

The FTSE 100 Index slid 65.9, or 1.2 percent, to 5,468.60. The FTSE All-Share Index fell 1.2 percent.

``The tone is clearly dovish,'' Jonathan Loynes, chief European economist at Capital Economics in London, said of the inflation report. ``We stick to the view that interest rates will eventually fall very sharply once inflation pressures finally recede.''

Job Losses

Unemployment rose for a sixth straight month, with the jobless rate climbing to 2.7 percent from 2.6 percent in June. Wages grew at the slowest pace in five years.

Banks and homebuilders are bearing the brunt of job losses as the housing slump deepens. Royal Bank of Scotland Group Plc said Aug. 8 it may shed as many as 7,000 jobs by 2010. Builders including Redrow Plc and Bovis Homes Group Plc have announced more than 4,000 job cuts since the start of July.

Redundancies threaten to deepen the unpopularity of Prime Minister Gordon Brown, whose Labour Party trails behind the opposition Conservatives by 20 points in opinion polls.

Brown has until June 2010 to hold the next election, and government hopes of an economic rebound before then are dimming. The International Monetary Fund last week slashed its forecasts for U.K. growth, and the Ernst & Young Item Club said in July that unemployment as measured by International Labor Organization standards may rise by a quarter to more than 2 million by 2010.

`Double Disaster'

``It is now clear that a prolonged slowdown is going to reproduce many of the bad conditions of the early 1990s,'' said Vince Cable, economics spokesman for the opposition Liberal Democrats. ``The government needs to move quickly to make sure people who lose their jobs don't face the double disaster of losing their homes as well.''

The Bank of England has left its benchmark rate unchanged since April to deter workers from demanding more pay to keep pace with living costs and fueling higher inflation, which reached a decade-high of 4.4 percent in July. Today's figures suggest the policy may be working.

Growth in average earnings fell to 3.4 percent in the three months through June, the lowest since August 2003 and down from 3.8 percent in the quarter through May. Excluding bonuses, the pace slowed 0.1 point to 3.7 percent, the least since January.

ILO-based unemployment rose to 5.4 percent in the three months through June, the highest since September last year. It compares with 7.3 percent in the euro region, 5.7 percent in the U.S. and 4.1 percent in Japan, the statistics office said.

Unemployment in the second quarter rose 60,000 to 1.67 million, the most since February-April, 2007. Employment increased 20,000 to 29.6 million. Vacancies at job centers in the three months through July fell 47,400 to 634,900, the lowest since December 2006.

To contact the reporters on this story: Jennifer Ryan in London at Jryan13@bloomberg.net; Brian Swint in London at bswint@bloomberg.net.